Eastern promise: will China deliver?

This week's Isa special looks at three funds that invest in the Far East.

Which funds are best for China and the Far East? It's a question people often ask as the phenomenal pace of economic development draws them towards the region when thinking of long-term places to invest their money.

There is a lot of merit in this thinking. The rise of China and its neighbours is fundamentally redrawing the global economy, with the balance of power shifting from West to East. Long-term investment returns from this trend are already stunning.

Over the past 10 years the average fund investing in and around China has delivered a total return of 232pc, making it the best sector by a mile. Funds investing more broadly in Asia Pacific (excluding Japan) have rewarded their investors handsomely too, generating average growth of 175pc.

However, economic growth and stock market returns do not always go hand in hand. Moreover, emerging markets like these are notoriously high risk, prone to huge fluctuations as hot money flows in and out.

The past year has seen the Chinese and other Asia Pacific stock markets plunge as investors dumped their holdings and fled to safe havens over fears of a sharp slowdown in China and the knock-on effects of the eurozone debt crisis.

In recent months, this has gone into reverse as investors have poured back into emerging markets, causing some fund managers to worry if they can cope with the sudden influx.

With concerns remaining about China's ability to avoid a "hard landing" after an unprecedented period of expansion, Citywire Selection has avoided selecting a China-focused fund. Instead, we have chosen two funds investing around a third of their investors' money in China, but also more broadly throughout the region.

To make things interesting, we have also included a Japan fund. Why? Japan has been the perennial disappointment to many UK investors. A 20-year period of deflation has hurt its stock market, and the chronic overvaluation of the yen has depressed returns for sterling-based investors. However, with some of the smartest investment brains allocating more money to Japan, it is possible even this country's depressed stock market could turn a corner.

First State Asia Pacific Leaders

We start with the gentle giant of the Asia Pacific excluding Japan sector. The £5.3 bn First State Asia Pacific Leaders fund is run by Angus Tulloch, a highly experienced investor in the region. Mr Tulloch's cautious approach has enabled the fund to avoid the worst losses when Asian markets fall and to capture most of the upside when they recover. In the past 12 months, as other funds in the sector have lost an average 7pc, Mr Tulloch's fund has been basically flat. Over five years, however, it is one of the sector's top funds, with an impressive total return of 91.3pc.

Mr Tulloch is sceptical about the Chinese government's ability to unwind the country's speculative property bubble without triggering a credit crunch. "Reversing these excesses, without giving rise to further nasty repercussions, is likely to prove difficult," he said.

Jonathan Miller, Citywire's head of research, said: "Angus Tulloch's prudent approach stands out in falling markets. He usually lags rallies in this volatile area, but the focus on protecting capital leaves investors on a firm footing over the long term."

Fidelity South East Asia

Allan Liu, manager of the £2.2 bn Fidelity South East Asia fund, takes a higher-risk approach. Although China, Hong Kong and South Korea are his main country weightings, he eschews Australasia, preferring a pure play approach to the region.

The fund has lost nearly 11pc in the past year, putting it towards the bottom of its sector. But it is likely to do well if markets make a sustained recovery. Over five years the fund has grown by 83pc.

Mr Miller said: "This is a more aggressive pick for the Asia region, where Allan Liu favours growth-oriented companies. This means there is higher exposure to cyclical companies and the fund is usually among the leaders when the market is in recovery mode."

Polar Capital Japan

Under manager James Salter, this fund focuses on smaller companies more than the big multinationals that dominate the attention of many overseas investors. Its five-year return of 23pc looks modest but is actually second in its sector.

Mr Miller said: "This fund isn't on the radar of many investors but the split between small, medium and large companies has consistently outperformed the Japanese market."